Once you have qualified for and been approved for a construction loan, the lender begins paying out the money they agreed to loan to you. However, they are not just going to give the builder the cash all at once. Instead, a schedule of draws is set up.
What is a construction loan?
Construction loans enable a new home to be built through the duration of construction. They are reflective of the time needed to build your home, and typically range from six months to a year. Once you have secured a construction loan, your lender will pay your builder after each interval of work is completed. Once construction ends, your loan repayment begins.
Many homebuyers choose the convenience of having their construction loan combined with their standard mortgage plan, in something called a construction-to-permanent loan. This eliminates the need to refinance after construction and undergo two separate closings.
How do construction loans work?
Your builder will outline how much money is required to build your home, segmenting expected costs into intervals of work. Your lender will compensate your builder after each interval, usually per month, once they have independently verified that the designated work has been completed.
When do you pay?
With most construction loans, you only pay interest on the amount of money that is drawn out each month. You will begin to repay your lender for the bulk costs after your home is completed. If the project is builder-financed, the construction loan is the builder’s responsibility and the buyer will not need to pay anything at all until the end of construction.
Compare Construction Loan vs. Traditional Home Loan
Construction loans work differently than traditional home loans. If you need help buying a home that is already built, whether new or old construction, a traditional home loan is right for you. If you want to build a home from scratch on your own lot of land, or buy a prospective home within a builder’s development, a construction loan is the way to go.
20%–30% down payment required
High interest rates
Incremental loan disbursements
More complicated to qualify for, and few options available
Must have specific building plans, construction contract, and cost estimate to apply
Traditional Home Loan
3.5%–20% down payment required depending on mortgage type
Low interest rates
Loan disbursement in one lump sum
Easier to qualify for, and more options available
Must only have essential personal finance information to apply
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